Here's why oil is poised for disruption

Here's why oil is poised for disruption

Talk about risky business. Over the last decade, oil went from being a necessary ingredient of global growth to being its primary constraint. New modeling is now blaming oil’s inability to keep up with demand as a primary driver for depressed American and global growth.

As a new Iraqi insurgency threatens the Persian Gulf oil basin, as China and Vietnam mix it up over drilling rights in the South China Sea, as Russia leverages its control of Eurasian hydrocarbons and as the planet approaches a climatic tipping point, it’s time to rethink our relationship to this vexing resource. Given the political stalemate in Washington, the prize for disruptive business ideas will grow as demand for mobility and demand for investment returns converge in the marketplace.

Here’s what happened. Since the end of World War II, mobility was the driver of growth and oil was a driver of mobility. In this country we know the story well. Since 1945, the U.S. population doubled and today, half of our population — essentially all of the population growth — lives in the car-dependent suburbs. This was not the product of the free market but of government intervention: the GI Bill, Fannie and Freddie, Truman’s 1951 executive order to disperse the population and industry out of our cities and the 1956 Interstate Highway and Defense Act tilted the housing market decisively from cities to suburbs. The federal support continues: Washington’s more than $450 billion of annual subsidies to real estate are predominantly supporting suburbs.

For America’s economy to grow, we had to add another ring of suburbs, which in the car-dependent suburbs mean more vehicle miles travelled, more time in the car and more gas guzzled.

In 2008, that formula for growth collapsed. As the Asian market expanded, Asian oil consumption outpaced oil supply and oil prices hit their all-time highs just after a record suburban growth spurt in the United States. We were driving a record number of miles to make ever-more-distant suburbs livable and we financed it with risky debt. When the oil prices doubled at the same time as the adjustable rate mortgages reset, many American households could not stay in the black and the defaults began to rack up. When you look at heat maps of mortgage defaults in the U.S., they are precisely in the regions where the housing and transportation costs were highest, in that belt of distant suburbs and exurbs.

It turns out global oil supply stalled in 2005 — while global demand was increasing, raising prices over the following three years. Now, says oil economist Steven Kopits, managing director of Douglas-Westwood, a global oil advisory firm, that undersupply has become the new normal.

Oil price, vehicle miles travelled and GDP are almost directly correlated, Kopits says. This is what being addicted to oil means. In 2005, just as prices started to rise, the data show that the U.S. hit “peak driving” in 2005 and the U.S. is still 8.9 percent below that peak, measured in vehicle miles travelled. Airline departures, also very price sensitive, are down too, 16 percent below their 2005 peak. The picture Kopits paints is that Americans are struggling to hold onto their mobility, which is key to employment in today’s America.

But what’s revolutionary about Kopits’ analysis is that the data show that the 2005 peak in supply is not due to a reduction in demand. Rather, it’s due to the absence of new supply. Historically, Douglas-Westwood figures show that oil supply should have expanded 23 percent from 2004 to 2013, but the actual supply growth was only 7.5 percent. Conventional oil peaked just as U.S. and Canadian unconventional projects came online. North American unconventional oil, derived from fracking or from processing tar sands, the most hazardous to the environment, has accounted for all of the growth in global petroleum supply since 2005.

Further, Kopits is clear that absence of new supply is not for lack of trying. Since 2005, the oil majors spent $4 trillion on upstream exploration and production, netting a reduction of 1 million barrels per day (mbpd) of conventional oil. From 1998 to 2005, by comparison, the total spend was $1.5 trillion and resulted in an increase of 8.6 mbpd.

All in, this oil-scarce global economy is reducing economic growth in the advanced OECD countries, including the U.S., by 1 percent to 2 percent per year. With the Federal Reserve, the White House and the IMF all scratching their heads about where the missing growth is, Kopits’ analysis provides some important answers.

With new supplies not on the horizon, the answer to unlocking growth lies in America’s approach to mobility. In other words, Kopits’ findings are an important argument in the case that it is now time to de-link the oil supply from transportation. Do that, and growth should recover nicely.

Here’s where the opportunity to disrupt America’s oil dependence comes in. First, demand for that next ring of suburbs is vanishing. The post-War American love affair with car-dependent suburbia has turned an important corner, with most Americans, 60 percent, now wanting to live in walkable, service-rich, transit-oriented communities rather than isolated, car-dependent suburbs. It’s not everyone, as large houses on large lots still make sense for many American families, but today’s demand for a new American dream is three times the post-war demand for suburbs in the first place. It’s America’s next — and biggest — economic opportunity. Further, new business models such as Tesla and ZipCar are showing American companies where the future of personal transportation is headed — a direction that matches up well with the smart growth designs that produce the walkability and convenience Americans increasingly desire.

Just as Tesla’s success harnessed a breakthrough in battery technology and a direct-to-customer sales model, future disruptions will be mash-ups of powerful ideas and plentiful capital. For example, with everyone asking about recharging stations and Tesla offering free power, the stage is being set for Solar City (also owned by Elon Musk) to deliver an EV charging station to every rooftop solar customer, and, for that matter, a parking lot full of them for commercial solar customers. With all those batteries tied to the grid, it’s a great way to provide resilience to our new smart grids, a service that can be quantified and profitable.

Suburbia itself is ready for disruption. With commercial suburban real estate depressed along with the surrounding homes, America is just waiting for smart growth’s Donald Trump to start buying up strings of suburban intersections, buying the land cheap, then transforming them into smart-growth town centers and linking them with fast, convenient transit — making a buck, improving mobility while also increasing the tax base. And it’s a win-win for local government: the standard 100,000-square-foot Walmart super store, along with its surface parking, has the same footprint as a 3,500-person village which would net more tax receipts per square foot than big box stores ever pay.

And the capital is there. Institutional investors are looking for durable investment hypotheses that tap into long-term, risk-mitigating trends to deliver attractive and reliable returns over the medium to long term. They are and will be investing in the kinds of infrastructure and equity plays that deliver sustained value over time, looking beyond the quarterly earnings report, apparently convinced that CK Prahalad was right.

The big asset managers are responding with an increasingly diverse and sizable line of products, such as JP Morgan’s NatureVest, FTSE/BlackRock’s Fossil-Free Index and the many pension-backed real-estate investment trusts that are investing in smart growth for the sake of their clients' well-being and their fiduciary obligation.

With Washington’s head in the sand and the economics of oil stuck in a period of high prices, the moment to bring disruptive business models into the American economy is now. Welcome to the new land of opportunity.